TB Chapter 14

Chapter 14: Multinational Capital Budgeting 7
Chapter 14
Multinational Capital Budgeting
1. If a U.S. parent is setting up a French subsidiary, and funds from the subsidiary will be periodically
sent to the parent, the ideal situation from the parent’s perspective is a ____ after the subsidiary is
established.
A) strengthening euro
B) stable euro
C) weak euro
D) B and C are both ideal.
ANSWER: A
2. According to the text, in order to develop a distribution of possible net present values from
international projects, a firm should use:
A) a risk-adjusted discount rate.
B) payback period.
C) certainty equivalents.
D) simulation.
ANSWER: D
3. When evaluating international project cash flows, which of the following factors is relevant?
A) future inflation.
B) blocked funds.
C) exchange rates.
D) all of the above
ANSWER: D
4. In general, increased investment by the parent in the foreign subsidiary causes more exchange rate
exposure to the parent over time because the cash flows remitted to the parent will be larger.
A) true.
B) false.
ANSWER: A
8 International Financial Management
5. Blocked funds may penalize a project if the return on the forced reinvestment in the foreign country
is less than the required rate of return on the project.
A) true.
B) false.
ANSWER: A
6. When assessing a German project administered by a German subsidiary of a U.S.-based MNC

solely from the German subsidiary’s perspective, which variable will most likely influence the
capital budgeting analysis?
A) the withholding tax rate.
B) the euro’s exchange rate.
C) the U.S. tax rate on earnings remitted to the U.S.
D) the German government’s tax rate.
E) A and C
ANSWER: D
7. In capital budgeting analysis, the use of a cumulative NPV is useful for:

A) determining a probability distribution of NPVs.
B) determining the time required to achieve a positive NPV.
C) determining how the required rate of return changes over time.
D) determining how the cost of capital changes over time.
E) A and B
ANSWER: B
8. Assume the parent of a U.S.-based MNC plans to completely finance the establishment of its
British subsidiary with existing funds from retained earnings in U.S. operations. According to the
text, the discount rate used in the capital budgeting analysis on this project should be most affected
by:
A) the cost of borrowing funds in the U.K.
B) the cost of borrowing funds in the U.S.
C) the parent’s cost of capital.
D) A and B
ANSWER: C
9. Assume a U.S.-based MNC has a Chilean subsidiary that annually remits 30 million Chilean pesos
to the U.S. If the peso _______, the dollar amount of remitted funds _______.
A) appreciates; decreases
B) depreciates; is unaffected
C) appreciates; is unaffected
D) depreciates; decreases
E) B and C
ANSWER: D
10. Assume an MNC establishes a subsidiary where it has no other existing business. The present
value of parent cash flows from this subsidiary is more sensitive to exchange rate movements when:
A) the subsidiary finances the entire investment by local borrowing.
B) the subsidiary finances most of the investment by local borrowing.
C) the parent finances most of the investment.

D) the parent finances the entire investment.
ANSWER: D
11. If an MNC exports to a country, then establishes a subsidiary to produce and sell the same product
in the country, then cash flows from prevailing operations would likely be _______ affected by the
project. If an MNC establishes a foreign manufacturing subsidiary that buys components from the
parent, the cash flows from prevailing operations would likely be _______ affected by the project.
A) adversely; adversely
B) favorably; adversely
C) favorably; favorably
D) adversely; favorably
ANSWER: D
12. An MNC is considering establishing a two-year project in New Zealand with a $30 million initial
investment. The firm’s cost of capital is 12%. The required rate of return on this project is 18%.
The project is expected to generate cash flows of NZ$12 million in Year 1 and NZ$30 million in
Year 2, excluding the salvage value. Assume no taxes, and a stable exchange rate of $.60 per NZ$
over the next two years. All cash flows are remitted to the parent. What is the break-even salvage
value?
A) about NZ$11 million.
B) about NZ$15 million.
C) about NZ$31 million.
D) about NZ$37 million.
E) about NZ$25 million.
ANSWER: E
SOLUTION:
1. NZ$12,000,000 x $.60 = $7,200,000 $7,200,000/(1.18) = $6,101,695
2. NZ$30,000,000 x $.60 = $18,000,000 $18,000,000/(1.18)2 = $12,927,320
$19,029,015
Break-even
salvage = [Initial outlay - PV of cash flows] (1 + k)m
value
= [$30,000,000 - $19,029,015] (1.18)2
= $15,276,000
Break-even salvage
value in NZ$ = $15,276,000/$.60 = NZ$25,459,999
13. A firm considers an exporting project and will invoice the exports in dollars. The expected cash
flows in dollars would be more difficult if the currency of the foreign country is ________.
A) fixed
B) volatile
C) stable
D) none of the above, as the firm is not exposed
ANSWER: B
14. If the parent charges the subsidiary administrative fees, the earnings from the project will appear
low to the parent and high to the subsidiary.
A) true.
B) false.
ANSWER: B
15. Other things being equal, a blocked funds restriction is more likely to have a significant adverse
effect on a project if the currency of that country is expected to _______ over time, and if the
interest rate in that country is relatively ______.
A) appreciate; low
B) appreciate; high
C) depreciate; high
D) depreciate; low
ANSWER: D
16. If a multinational project is assessed from the subsidiary’s perspective, withholding taxes are
ignored for project assessment.
A) true.
B) false.
ANSWER: A
17. Other things being equal, firms from a particular home country will engage in more international
acquisitions if they expect foreign currencies to _______ against their home currency, and if their
cost of capital is relatively _______.
A) appreciate; low
B) appreciate; high
C) depreciate; high
D) depreciate; low
ANSWER: A
18. The discrepancy between the feasibility of a project in a host country from the perspective of the
U.S. parent versus the subsidiary administering the project is likely to be greater for projects in
countries where:
A) the taxes are the same as in the U.S.
B) there are no blocked fund restrictions.
C) the currency of the host country is expected to depreciate consistently.
D) none of the above; a discrepancy is not possible.
ANSWER: C
19. The break-even salvage value of a particular project is the salvage value necessary to:
A) offset any losses incurred by the subsidiary in a given year.
B) offset any losses incurred by the MNC overall in a given year.
C) make the project have zero profits.
D) make the project’s return equal the required rate of return.
ANSWER: D
20. The impact of blocked funds on the net present value of a foreign project will be greater if interest
rates are _______ in the host country and there are _______ investment opportunities in the host
country.
A) very high; limited
B) very low; limited
C) very low; numerous
D) very high; numerous
ANSWER: B
21. One foreign project in Hungary and another in Japan had the same perceived value from the U.S.
parent’s perspective. Then, the exchange rate expectations were revised, upward for the value of
the Hungarian forint and downward for the Japanese yen. The break-even salvage value for the
project in Japan would now be _______ from the parent’s perspective.
A) negative
B) higher than that for the Hungarian project
C) lower than that for the Hungarian project
D) the same as that for the Hungarian project
E) A and C
ANSWER: B
22. Exchange rates for purposes of multinational capital budgeting:

A) are very difficult to forecast.
B) can be easily hedged with currency swaps.
C) are unimportant, as they do not affect the cash flows of the multinational project.
D) all of the above
ANSWER: A
23. A U.S.-based MNC has just established a subsidiary in Algeria. Shortly after the plant was built,
the MNC determines that its exchange rate forecasts, which had previously indicated a slight
appreciation in the Algerian dinar were probably false. Instead of a slight appreciation, the MNC
now expects that the dinar will depreciate substantially due to political turmoil in Algeria. This new
development would likely cause the MNC to __________ its estimate of the previously computed
net present value.
A) lower
B) increase
C) lower, but not necessarily if the MNC invests enough in Algeria to offset the decrease in NPV
D) increase, but not necessarily if the MNC reduces its investment in Algeria by an offsetting
amount
E) none of the above
ANSWER: A
The following information refers to questions 24 through 26.
Assume that Baps Corporation is considering the establishment of a subsidiary in Norway. The initial
investment required by the parent is $5,000,000. If the project is undertaken, Baps would terminate the
project after four years. Baps’ cost of capital is 13%, and the project is of the same risk as Baps’
existing projects. All cash flows generated from the project will be remitted to the parent at the end of
each year. Listed below are the estimated cash flows the Norwegian subsidiary will generate over the
project’s lifetime in Norwegian kroner (NOK):
Year 1 Year 2 Year 3 Year 4

NOK10,000,000 NOK15,000,000 NOK17,000,000 NOK20,000,000
The current exchange rate of the Norwegian kroner is $.135. Baps’ exchange rate forecast for the
Norwegian kroner over the project’s lifetime is listed below:
Year 1 Year 2 Year 3 Year 4

$.13 $.14 $.12 $.15
24. What is the net present value of the Norwegian project?

A) -$803,848.
B) $5,803,848.
C) $1,048,829.
D) none of the above
ANSWER: C
SOLUTION:
Year 0 Year 1 Year 2 Year 3 Year 4
Cash flow to parent -$5,000,000 $1,300,000 $2,100,000 $2,040,000 $3,000,000
PV of parent cash flow 1,150,442 1,644,608 1,413,822 1,839,956
Cumulative NPV -3,849,558 -2,204,950 -791,128 1,048,828
25. Assume that NOK8,000,000 of the cash flow in year 4 represents the salvage value. Baps is not
completely certain that the salvage value will be this amount and wishes to determine the break-even
salvage value, which is $___________.
A) 510,088.04
B) 1,710,088
C) 1,040,000
ANSWER: D
SOLUTION: Even if there is no salvage value, the NPV would still be positive, as shown below:

Cumulative NPV -3,849,558 -2,204,950 -791,128 312,846
26. Baps is also uncertain regarding the cost of capital. Recently, Norway has been involved in some
political turmoil. What is the net present value (NPV) of this project if a 16% cost of capital is used
instead of 13%?
A) -$17,602.62.
B) $8,000,000.
C) $1,048,829.
D) $645,147.
ANSWER: D
SOLUTION:
Cumulative NPV -3,879,310 -2,318,668 -1,011,726 645,147
27. Petrus Company has a unique opportunity to invest in a two-year project in Australia. The project is
expected to generate 1,000,000 Australian dollars (A$) in the first year and 2,000,000 Australian
dollars in the second. Petrus would have to invest $1,500,000 in the project. Petrus has determined
that the cost of capital for similar projects is 14%. What is the net present value of this project if the
spot rate of the Australian dollar for the two years is forecasted to be $.55 and $.60, respectively?
A) $2,905,817.
B) -$94,183.
C) $916,128.
ANSWER: B
SOLUTION:
Year 0 Year 1 Year 2
Cash flow to parent $1,500,000 $550,000 $1,200,000
PV of parent cash flow 482,456 923,361
Cumulative NPV -1,017,544 -94,183
28. Which of the following is not a characteristic of a country to be considered within an MNC’s
international tax assessment?
A) corporate income taxes.
B) withholding taxes.
C) provisions for carrybacks and carryforwards.
D) tax treaties.
E) all of the above are characteristics to be considered.
ANSWER: E
29. Like income tax treaties, ____________ help to avoid double taxation and stimulate direct foreign
investment.
A) withholding taxes
B) excise taxes
C) tax credits
D) carryforwards
ANSWER: C
30. If the parent’s government imposes a _______ tax rate on funds remitted from a foreign subsidiary,
a project is less likely to be feasible from the _________ point of view.
A) high; subsidiary’s
B) high; parent’s
C) low; parent’s
D) A and C
E) none of the above
ANSWER: B
31. If a subsidiary project is assessed from the subsidiary’s perspective, then an expected appreciation
in the foreign currency will affect the feasibility of the project ________.
A) positively
B) negatively
C) either positively or negatively, depending on the percentage appreciation
ANSWER: D
32. When a foreign subsidiary is not wholly owned by the parent and a foreign project is partially
financed with retained earnings of the parent and of the subsidiary, then:
A) the parent’s perspective should be used to evaluate a foreign project.
B) the subsidiary’s perspective should be used to evaluate a foreign project.
C) the foreign project should enhance the value of both the parent and the subsidiary.
ANSWER: C
33. The __________ is likely the major source of funds to support a particular project.
A) initial investment
B) variable costs
C) fixed costs
ANSWER: A
34. Because before-tax cash flows are necessary for an adequate capital budgeting analysis,
international tax effects need not be determined on a proposed foreign project.
A) true.
B) false.
ANSWER: B
35. The required rate of return of a project is _____________ the MNC’s cost of capital.
A) greater than
B) less than
C) the same as
D) any of the above, depending on the specific project
ANSWER: D
36. An international project’s NPV is _________ related to the size of the initial investment and
_________ related to the project’s required rate of return.
A) positively; positively
B) positive; negatively
C) negatively; positively
D) negatively; negatively
ANSWER: D
37. An international project’s NPV is _________ related to consumer demand and _________ related
to the project’s salvage value.
A) positively; positively
B) positive; negatively
C) negatively; positively
D) negatively; negatively
ANSWER: A
38. Everything else being equal, the _________ the depreciation expense is in a given year, the
________ a foreign project’s NPV will be.
A) higher; lower
B) higher; higher
C) lower; higher
ANSWER: B
39. A foreign project generates a negative cash flow in year 1 and positive cash flows in years 2 through
5. The NPV for this project will be higher if the foreign currency _________ in year 1 and
_________ in years 2 though 5.
A) depreciates; depreciates
B) appreciates; appreciates
C) depreciates; appreciates
D) appreciates; depreciates
ANSWER: C
40. If an MNC sells a product in a foreign country and imports partially manufactured components
needed for production to that country from the U.S., then the local economy’s inflation will have:
A) a more pronounced impact on revenues than on costs.
B) a less pronounced impact on revenues than on costs.
C) the same impact on revenues as on costs.
ANSWER: A
41. When conducting a capital budgeting analysis and attempting to account for effects of exchange
rate movements for a foreign project, inflation __________ included explicitly in the cash flow
analysis, and debt payments by the subsidiary _________ included explicitly in the cash flow
analysis.
A) should be; should be
B) should definitely not be; should definitely not be
C) should definitely not be; should be
D) should be; should definitely not be
ANSWER: A
42. As the financing of a foreign project by the parent _______ relative to the financing provided by the
subsidiary, the parent’s exchange rate exposure _________.
A) increases; decreases
B) decreases; increases
C) increases; increases
ANSWER: C
43. In conducting a multinational capital budgeting analysis, the subsidiary’s perspective should always
be used.
A) true.
B) false.
ANSWER: B
44. The feasibility of a multinational project from the parent’s perspective is dependent not on the
subsidiary cash flows but on the cash flows that it ultimately receives.
A) true.
B) false.
ANSWER: A
45. The required rate of return used to discount the relevant cash flows from a foreign project may
differ from the MNC’s cost of capital because of that particular project’s risk.
A) true.
B) false.
ANSWER: A
46. In multinational capital budgeting, depreciation is treated as a cash outflow.

A) true.
B) false.
ANSWER: B
47. No matter what the probability distribution of future exchange rates is, as long as one out of several
scenarios results in a negative net present value (NPV), a project should not be accepted.
A) true.
B) false.
ANSWER: B
48. If a foreign project is financed with a subsidiary’s retained earnings, the subsidiary’s investment
could be viewed as an opportunity cost, since the funds could be remitted to the parent rather than
invested in the foreign project.
A) true.
B) false.
ANSWER: A
49. If a host government restricts the remittances from a foreign subsidiary, a possible solution is to let
the subsidiary obtain partial financing for the project.
A) true.
B) false.
ANSWER: A

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Chapter 14: Multinational Capital Budgeting 7

Multinational Capital Budgeting

6. When assessing a German project administered by a German subsidiary of a U.S.-based MNC

7. In capital budgeting analysis, the use of a cumulative NPV is useful for:

C) the parent finances most of the investment.

22. Exchange rates for purposes of multinational capital budgeting:

The following information refers to questions 24 through 26.

Year 1 Year 2 Year 3 Year 4

Year 1 Year 2 Year 3 Year 4

24. What is the net present value of the Norwegian project?

Year 0 Year 1 Year 2 Year 3 Year 4

46. In multinational capital budgeting, depreciation is treated as a cash outflow.

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